National Income | Meaning of National Income | Market Prices and Factor Costs

National Income | Meaning of National Income | Market Prices and Factor Costs

National Income

National income is the most comprehensive measure of the level of the aggregate economic activity in an economy. It is the total income of a nation as against the income of an individual but you must note that the term national income is not as simple and self-explanatory as the concept of individual income maybe.

Meaning of National Income

National income is the aggregate of money value of the annual flow of final goods and services in the economy during a given period. The well-known writer, Paul Studenski, writes: "National income is both a flow of goods and services and a flow of money incomes. It is therefore called national product as often as national income".

Flow Of National Income

The flow of national income begins when production units combine capital and labour and turn out goods and services. We call this Gross National Product GNP. It is the value of all final goods and services produced by domestically owned factors of production within a given period. Example: It includes the value of goods produced such as houses and food grains and the value of services such as broker's services and economist's lectures. The output of each of these is valued at its market price and the values are added together to give GNP. At the same time, the production units which produce goods and services, distribute money incomes to all who help in production in the form of wages, rent, interest and profit we call this as Gross National Income (GN) GNI comprises the total value produced within a country, together with its income received from other countries less similar payments made to other countries. It may be noted from above that:

National Income Aggregative Value Concept

National Income is an Aggregative Value Concept: It makes use of the value determined by the measuring rod of money as the common denominator for the purpose of aggregating the diverse output resulting from different types of economic activities.

National Income is a Flow Concept: It represents a given amount of aggregate production per unit of time, conventionally represented by one year. Thus, national income usually relates to a particular year and indicates the output during that year. National income represents the aggregate value of final products rather than the total value of all kinds of products produced in the economy. The insistence on final goods and services is simply to make sure that we do not double count National Aggregates (Important Concepts)

Measurement and Analysis, National Income

For the purpose of measurement and analysis, national income can be viewed as an aggregate of various component flows. Generally these component flows represent the inter-sectoral transactions which describe the broad structure of the economic system. Accordingly, there exist several measures of aggregate incomes varying in their scope and coverage To begin with let us consider the most comprehensive and broad-based measure of aggregate income widely known as Gross National Product at market prices or GNPMP. It shows the market value of the aggregate final product before the deduction of provisions for the consumption of fixed capital. attributable to the factors of production supplied by the normal residents of a country. Two important words are "gross" and "national" Similarly the phrase "at market prices" is also significant because it specifies the criterion of valuation. The main alternatives to these three specifications are 'net', 'domestic and at factor cost.

Gross and Net Concepts

Gross emphasises that no allowance for capital consumption has been made or that depreciation has yet to be deducted. Net indicates that provision for capital consumption has already been made or that depreciation has already been deducted. Thus, the difference between the gross aggregate and the net aggregate is depreciation ie,

GNP at market price/factor cost=NNP at market price factor+ depreciation

National and Domestic Concepts

The concept of national versus domestic arises because of the fact that the economy is not closed in the sense that it has transactions with the rest of the world in the form of exports and imports gifts, loans, factor income flows, etc. National income or product is that income or product which accrues to the economic agents who are resident of the country. Most of the national income is derived from economic activity within the country. But some income arises due to the activities of the residents outside the country. Similarly, some of the product or income arising in the country may be due to the activities of the non-residents. The difference between these two flows is referred to as net factor income from abroad. The measure of production arising out of the activities of economic agents within the country is termed as domestic product even if a part of that income accrues to non-residents. When adjustments are made to this product by deducting the income of non-residents within the country and adding the income of residents abroad, the national product is obtained. Hence, the difference between the national and domestic concept is the net factor income from abroad and

in a closed economy national and domestic incomes are synonymous GNP at market price/factor cost-GDP at market price factor cost+Net factor income from Abroad NNP from abroad market price factor cost=NDP at market price/factor cost - Net factor income

Net factor income from abroad Factor income received from abroad - Factor income paid abroad.

Market Prices and Factor Costs

The valuation of the national product at market prices indicates the total amount actually paid by the final buyers while the valuation of national product at factor cost is a measure of the total amount eamed by the factors of production for their contribution to the final output. GNPMP GNP at factor costs indirect taxes-Subsidies. (Note: GNP at factor costs can also be written as GNPFC)

NNPMP NNPFC+ indirect taxes Subsidies

Circular Flow of Income

Circular flow of income model shows the flow of income between the producers and the households who buy their goods or services. Income moves from households to producers as the households purchase goods or services and income moves from producers to households in the form of wages or profits.

Circular Flow of Income in a 2 Sector Model One of the most important insights about the aggregate economy is that it is a circular flow in which output and input are interrelated (Figure 1) Household's expenditures (consumption and saving) and firm's expenditures wages, rents, etc.) are household's income.

Figure 1 Circular Flow of Income in a 2 Sector Model

The circular flow of income model is a model used to show the flow of income through an economy. Through showing the leakages in the economy and the injections, the different factors affecting the economic activities are apparent. Just like a leakage in a bucket leads to decrease in the level of water, a leakage in the economy leads to a decrease in economic activity. And just like an injection into the bucket where the water level rises, an injection in an economy leads to an increase in economic activity.

Basic Assumptions of a Simple Circular Flow

The economy consists of two sectors: households and firms.

Households spend all of their income (Y) on goods and services or consumption (C)

There is no saving (S). All output (O) produced by firms is purchased by households through their expenditure (E). There is no financial sector.

There is no government sector.

There is no overseas sector.

In the simple two sector circular flow of income model the state of equilibrium is defined as a situation in which there is no tendency for the levels of income (Y), expenditure (E) and output

(O) to change, that is: Y-E-O.

This means that all household income (Y) is spent (E) on the output (0) of firms, which is equal in value to the payments for productive resources purchased by firms from households. Excomple: This can be shown in an example where John earns 100.00, he doesn't save it and spends it all on the goods and services (O) provided by the firms.

Sector Model with Financial Market

Financial institutions act as intermediaries between savers and investors. All the lending and borrowings are carried on in the financial or capital market. All that is eamed by the households is not spent on consumption; a part of it is saved. This saving is deposited in the financial market leading to a money flow from the household to the financial market. On the other hand, the firm saves to meet its depreciation expenses and expansion The savings of the firm going into the financial market and borrowings made by the firm from the financial market also create money flows.

Therefore, we can say that the savings by households and firms are leakages and borrowings by the firms act as injections into the circular flow of income.